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Research Update:

Swiss Canton of Zurich Affirmed At

'AAA' On Strong Economy And Very

Positive Liquidity; Outlook Stable

Sabine Daehn, Frankfurt (49) 69-33-999-244; [email protected]

Secondary Contact:

Alois Strasser, Frankfurt (49) 69-33-999-240; [email protected]

Table Of Contents

Overview

Rating Action

Rationale

Outlook

Published Rating Factor Scores

Key Statistics

Key Sovereign Statistics

Related Criteria And Research

Ratings List

Swiss Canton of Zurich Affirmed At 'AAA' On

Strong Economy And Very Positive Liquidity;

Outlook Stable

Overview

• The Swiss Canton of Zurich benefits from a very strong economy and very

positive liquidity position.

• We believe the canton will maintain a low debt burden.

• We are affirming our 'AAA' long-term issuer credit rating on Zurich.

• The stable outlook reflects our expectation that the canton's management

will remain committed to consolidating the budget and stabilizing budgetary performance.

Rating Action

On Nov. 29, 2013, Standard & Poor's Ratings Services affirmed its 'AAA' long-term issuer credit rating on the Swiss Canton of Zurich. The outlook is stable.

Rationale

The rating reflects our view of the canton's very wealthy and diversified economy, as well as Switzerland's "predictable and supportive" institutional framework in which Zurich contributes to the equalization system. Zurich displays a "very positive" liquidity position and "high" budgetary

flexibility, in our view. This should allow the canton's management to

maintain a fair budgetary performance over the coming years. Nevertheless, we expect a slight deterioration of Zurich's budgetary performance and,

consequently, larger funding needs over 2013-2016. Zurich's debt increases because of financing the pension fund gap and investment needs to a moderately low level. However, we note the canton's strong political commitment to

balancing accounts over the medium term, as shown by its track record of positive results. The ratings are constrained by moderate contingent liabilities from the canton's guarantee to Zuercher Kantonalbank (ZKB).

In our view, Zurich has a very wealthy regional economy, relative to national and international peers. The canton is the core financial center of

Switzerland, and it contributes more than one-fifth of the national gross value added. We estimate Zurich's GDP per capita at about Swiss franc (CHF) 91,000 in 2013, which is almost 200% of the EU-28 average. As a result, Zurich contributes the largest amount to the national equalization system, equaling almost 3% of its adjusted operating expenditures. We classify the Swiss

institutional framework as "predictable and supportive," owing to its strong and stable equalization system, which we expect to remain largely unchanged over the medium term.

Some of Zurich's expenditure items--such as payments to the equalization system--are rather inflexible. But the canton's overall budgetary flexibility is stronger than that of most of its Swiss peers, due to a very high share of modifiable revenues. Even though tax competition and public opposition

somewhat limit the canton's willingness to raise taxes, the medium-term balancing requirement partly offsets this effect, and we believe the canton would use its flexibility if needed. Nevertheless, we observe a greater focus on expenditure management with respect to investments and operating costs. While the canton contains costs and continues to implement its savings program for 2010-2014, it is also prioritizing investment projects, targeting an

investment volume of about 65% of the total projects proposed. This more

detailed approach is part of the canton's budgetary process-improvement plans, as the government is strengthening its grip on consolidation. The plan

includes setting financial cornerstones far in advance of the budgeting and planning process, which should result in firmer budgets and financial plans and a quicker return to annually balanced budgets. Also, Zurich ultimately intends to cease applying global savings measures in the budgetary process. Overall, we continue to view the canton's financial management as "very positive" for the rating, due to its approval-based annual budgeting process and strong commitment to balancing accounts over the medium term of a rolling eight-year period.

Nevertheless, we have observed some slippage. Zurich's results were weaker in 2012 than in 2011, albeit similar to our projections. We do not see the

canton's ongoing cost-cutting measures over the forecast period as sufficient to achieve balanced budgets in the planning period. Although the 2010-2012 average operating balance was 8% of adjusted operating revenues, and the balance after capital accounts was positive, our base-case scenario assumes weaker results for the next three years with deficits after capital accounts. In our base case for 2013, the canton's budget reflects the financing of the pension fund as a capital expense of CHF2 billion. Even excluding this

one-time measure, we forecast an operating surplus of 3.4% of operating revenues and a deficit after capital accounts of 2.3% of adjusted total revenues, weaker than in previous years. There are several reasons for this decline, including the impact of the hospital funding reform and lower tax revenue growth. Zurich's recapitalization of the pension fund resulted in a provision of CHF2.6 billion in 2011 in its accounts, which we however excluded as a non-cash item. Still, we include the annual pension fund consolidation contributions as a cash-relevant expense item and the above mentioned cash injection. Overall, these factors lead to our base-case forecast of moderate budgetary performance. Including the adjustments for the pension fund

recapitalization, the average results over 2011-2015 are an operating surplus of almost 5% of adjusted operating revenues and a deficit after capital

accounts of about 4% of total adjusted revenues.

Research Update: Swiss Canton of Zurich Affirmed At 'AAA' On Strong Economy And Very Positive Liquidity; Outlook Stable

Zurich's nominal debt has increased substantially, due to the pension fund contribution of CHF2 billion in 2013, and we expect it to rise further if the canton finances its budgetary deficits with debt issuance. However, we

estimate that the canton's low tax-supported debt will remain at about 40% of consolidated operating revenues by 2016, depending on its use of liquidity reserves and conditions in capital markets.

The canton has also given a legal guarantee for practically all of ZKB's liabilities. The rating on the canton would be put under pressure if ZKB were to call on the guarantee or rely on the canton for a considerable capital injection. We currently view the likelihood of this occurring as very low, given the bank's strong stand-alone credit profile of 'aa-'. Consequently, we assess the canton's contingent liabilities as moderate.

Liquidity

We view Zurich's liquidity position as very positive. Our assessment takes into account the canton's high level of cash reserves, committed bank lines, and strong access to Switzerland's deep and liquid capital market, as

demonstrated by bond issuances throughout 2013. Furthermore, in the event of financial distress, the canton could benefit from its ties with the cantonal bank, which has access to central bank refinancing.

The canton's available cash reserves totalled CHF770 million on Oct. 31, 2013. These amounts, combined with the canton's bank lines, are sufficient to cover the next 12 months' debt service of CHF1.14 billion (principal and interest). However, we observe a drop in free cash and liquid assets compared with

year-end 2012 because the canton had reserved liquidity for the pension fund contribution in 2013.

In our view, the canton has highly predictable cash flows, which form the basis of its liquidity planning. Yearly interest payments are low and stable at about 1% of operating revenues. Debt service, however, will be higher than in the past two years due to substantial repayments in 2014 (CHF1 billion) and 2016 (CHF500 million).

Zurich plans for an average minimum cash position of CHF500 million, slightly below 4% of operating expenditures. The canton has access to a variety of international banks and two credit lines totalling CHF500 million that we regard as committed under our criteria.

Outlook

The stable outlook reflects our base-case scenario that, in 2014-2015,

Zurich's balance after capital accounts will stabilize and its management will remain committed to consolidating the budget. Therefore, besides tax revenue growth, we expect further cost-containment measures that would allow the

canton to balance results after capital accounts over the medium to long term. Furthermore, our base case assumes that debt levels will not deviate

substantially from about 40% of operating revenues over the forecast period. We could lower the rating if Zurich's fiscal performance deteriorated further, resulting in operating and after-capital accounts deficits, the latter beyond 5% of total adjusted revenues on average. In addition to signaling a weakening of managerial strength, such deficits could lead to a substantial increase of debt, above 60% of consolidated operating revenues. Moreover, significant financial difficulties at ZKB could burden the ratings. However, we currently view these events as highly unlikely.

Published Rating Factor Scores

Canton of Zurich Summary Of Published Rating Factor Scores*

Rating factor Score

Institutional framework Supportive and predictable

Financial management Very positive

Liquidity Very postive

*Standard & Poor's ratings on local and regional governments are based on, among other things, a scoring system that covers eight main rating factors. We publish our scores for the three rating factors above.

Key Statistics

Canton of Zurich Economic Statistics

--Financial year ends Dec.

31--2009 2010 2011 2012 2013bc 2014bc

Population 1,351,300 1,373,100 1,392,400 1,408,600 1,428,320 1,448,320

Population growth (%) 1.4 1.6 1.4 1.2 1.4 1.4

GDP per capita (CHF) 90,888 90,160 92,553 91,126 90,856 91,215

Unemployment rate (%) 3.7 3.6 2.9 3.0 N/A N/A

Note: The data and ratios above result in part from Standard & Poor's own calculations, drawing on national and international sources, reflecting Standard & Poor's independent view on the timeliness, coverage, accuracy, credibility, and usability of available information. Sources typically include national statistical offices, Eurostat, and Experian Limited. bc--Standard & Poor's base-case forecast, reflecting its expectations of the most likely scenario. CHF--Swiss franc. N/A--Not applicable.

Table 3

Canton of Zurich Financial Statistics

--Financial year ending Dec.

31--(Mil. CHF) 2009 2010 2011 2012 2013bc 2014bc 2015bc

Operating revenues 11,552 12,708 13,318 13,500 13,470 13,691 14,031 Operating expenditures 11,220 11,478 11,873 12,956 13,011 13,473 13,661

Operating balance 332 1,230 1,445 544 459 218 370

Operating balance (% of operating revenues) 2.9 9.7 10.8 4.0 3.4 1.6 2.6

Capital revenues 184 165 113 145 63 40 59

Research Update: Swiss Canton of Zurich Affirmed At 'AAA' On Strong Economy And Very Positive Liquidity; Outlook Stable

Table 3

Canton of Zurich Financial Statistics (cont.)

Capital expenditures (capex) 948 889 897 802 2,828 758 726

Balance after capital accounts (432) 506 661 (113) (2,306) (500) (297) Balance after capital accounts (% of total

revenues)

(3.7) 3.9 4.9 (0.8) (17.0) (3.6) (2.1)

Debt repaid 925 572 50 50 700 1,000 225

Balance after debt repayment and onlending (1,381) (94) 646 (38) (3,002) (1,448) (457) Balance after debt repayment and onlending (%

of total revenues)

(12) (1) 5 (0) (22) (11) (3)

Gross borrowings 0 200 0 1,000 1,500 1,200 250

Balance after borrowings (1,381) 106 646 962 (1,502) (248) (207)

Operating revenue growth (%) 9.0 10.0 4.8 1.4 (0.2) 1.6 2.5

Operating expenditure growth (%) 18.4 2.3 3.4 9.1 0.4 3.6 1.4

Modifiable revenues (% of operating revenues) 75.3 76.3 77.3 74.6 74.8 73.7 73.3

Capex (% of total expenditures) 7.8 7.2 7.0 5.8 17.9 5.3 5.0

Direct debt (outstanding at year-end) 3,772 3,400 3,350 4,300 5,100 5,300 5,325 Direct debt (% of operating revenues) 32.6 26.8 25.2 31.9 37.9 38.7 38.0 Tax-supported debt (% of consolidated

operating revenues)

32.8 26.9 25.3 32.0 38.0 38.8 38.1

Interest (% of operating revenues) 1.5 1.3 1.6 1.6 1.2 1.0 1.1

Debt service (% of operating revenues) 9.6 5.8 2.0 2.0 6.3 8.3 2.7

Note: The data and ratios above result in part from Standard & Poor's own calculations, drawing on national and international sources, reflecting Standard & Poor's independent view on the timeliness, coverage, accuracy, credibility, and usability of available information. The main sources are the financial statements and budgets, as provided by the issuer. bc--Standard & Poor's base-case forecast, reflecting its expectations of the most likely scenario. CHF--Swiss franc.

Key Sovereign Statistics

• Sovereign Risk Indicators, July 1, 2013

Related Criteria And Research

• International Local And Regional Governments Default And Transition

Study: 2012 Saw Defaults Spike, March 28, 2013

• Principles Of Credit Ratings, Feb. 16, 2011

• Methodology For Rating International Local And Regional Governments,

Sept. 20, 2010

• Methodology And Assumptions For Analyzing The Liquidity Of Non-U.S. Local

And Regional Governments And Related Entities And For Rating Their Commercial Paper Programs, Oct. 15, 2009

• Public Finance System Overview: Swiss Cantons, July 30, 2009

In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And

Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision.

After the primary analyst gave opening remarks and explained the

recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts. The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook.

Ratings List

Issuer Credit Rating

AAA/Stable/--Senior Unsecured AAA

Additional Contact:

International Public Finance Ratings Europe; [email protected]

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Research Update: Swiss Canton of Zurich Affirmed At 'AAA' On Strong Economy And Very Positive Liquidity; Outlook Stable

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